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Small-Cap Financial Stocks Offer Room to Grow, and Some Dividends, Too

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Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some small-cap financial stocks stocks to your portfolio but don't have the time or expertise to hand-pick a few, the PowerShares S&P SmallCap Financials ETF (NASDAQ: PSCF  ) could save you a lot of trouble. Instead of trying to figure out which small-cap financial stocks will perform best, you can use this ETF to invest in lots of them simultaneously.

The basics
ETFs often sport lower expense ratios than their mutual fund cousins. This ETF, focused on small-cap financial stocks, sports a relatively low expense ratio -- an annual fee -- of 0.44%. It recently yielded about 2.5%, and the fund is fairly small, too, so if you're thinking of buying, beware of possibly large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

This small-cap financial stocks ETF has outperformed the world market over the past three years. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.

Why small-cap financial stocks?
Small-cap stocks are generally less proven than their larger counterparts, and they can be more risky. Still, the best among them are on their way to being large companies, with much room to grow and profits to offer shareholders. This ETF contains a bunch of small-cap financial stocks along with some larger ones.

More than a handful of small-cap financial stocks had strong performances over the past year. Texas Capital Bancshares (NASDAQ: TCBI  ) gained 34%, and is near a 52-week high. Its third quarter featured earnings missing expectations but deposits also growing and net interest margin rising. Analysts at Zacks Equity research have a neutral rating on Texas Capital Bancshares, liking its consistent loan and deposit growth, but worrying about its rising expenses and provision for loan losses.

F.N.B. Corp. (NYSE: FNB  ) advanced 23%, with a dividend yield near 3.9%. F.N.B. reports its fourth quarter on the 21st. After reporting its last quarter, management noted, "A key profitability driver is our ability to deliver consistent loan and low cost deposit growth." It added, "From a mobile banking initiative that produces revenue growth and account acquisition to consistent investment in our risk management infrastructure, we are continuously balancing efficiency, growth and risk management."

Other small-cap financial stocks didn't do quite as well over the last year, but could see their fortunes change in the coming years. Prospect Capital (NASDAQ: PSEC  ) gained 13%, but that was far below the overall market's return. Prospect is a private equity business development company ("BDC"), recently yielding a huge 11.8%. Bulls are hopeful that a new regulatory framework, Basel III, will drive more profits for Prospect Capital. Prospect has been beefing up its real estate investments lately.

Susquehanna Bancshares (NASDAQ: SUSQ  ) gained 20% and yields 2.6%. Its third quarter featured net income up 21%, loan growth of 5.5%, and improving credit quality. In its conference call, management was admirably candid: "Our third quarter results showed progress in some of our key objectives, including year-over-year growth in commercial and consumer loans and continued improvement in credit quality. However, the quarter also provided reminders of the challenging environment we operate in, with deposits largely flat and the up-tick in rates slowing volume in some of our fee generating activities."

The big picture
If you're interested in adding some small-cap financial stocks to your portfolio, consider doing so via an ETF. A well-chosen ETF can grant you instant diversification across any industry or group of companies -- and make investing in and profiting from it that much easier.

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Selena Maranjian

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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